TODAY’S UNSUSTAINABLE BUDGET POLICY: A RECOUNT
Benjamin Harris, Eugene Steuerle, and Caleb Quakenbush
Urban-Brookings Tax Policy Center
January 30, 2013
ABSTRACT
Although the recently passed American Taxpayer Relief Act instituted meaningful deficit
reduction relative to previous policy, it still left the budget a far distance from any sustainable
path. Under a plausible scenario, deficits never fall below 3.4 percent of GDP and rise to 5.4
percent of GDP by 2022. Given this baseline, an additional $150-$300 billion of annual deficit
reduction, instituted after the economy has fully recovered, would put the budget on a stable path
in the intermediate term while allowing for continued economic recovery. Yet even that path
leaves longer-term budget problems unresolved. Without a more far-reaching agreement over
such long-term issues, policymakers may have limited leeway to respond to new emergencies
and meet the demographic pressures of the forthcoming decade.
TODAY’S UNSUSTAINABLE BUDGET POLICY: A RECOUNT
Although the American Taxpayer Relief Act raises taxes by about $600 billion over 10 years
relative to previous policy, it still leaves the United States a far distance from any sustainable
path. Under a plausible scenario, deficits never fall below 3.4 percent of GDP in the next few
years and rise to 5.4 percent of GDP by 2022—in essence, a reversion to prior policy with
somewhat higher tax revenues. Cutting the deficit by about $150 billion a year between 2015 and
2018, and by $300 billion a year thereafter, would theoretically put the budget on a stable path in
the intermediate term while allowing for continued economic recovery. Yet, unless longer-term
budget problems are tackled, even that path leaves little room to respond to any new recession or
emergency, puts discretionary spending at or below a multidecade low, squeezes most programs
for children and investment, and leaves the country unprepared for the further demographic and
health cost pressures of the forthcoming decade.
Deficit Reduction after the American Taxpayer Relief Act
To the relief of many, Congress passed the American Taxpayer Relief Act (ATRA) on December
31, 2012, avoiding most scheduled expirations of various tax cuts while implementing a twomonth stay on steep discretionary spending cuts, which are typically referred to as the sequester.
This deal, which forestalled the vast bulk of the “fiscal cliff,” added $4.0 trillion to the 10-year
deficit when measured relative to a current law with all those scheduled tax increases, but it
subtracted $620 billion from the deficit when measured relative to ongoing policy.1 Faced with a
fundamental trade-off between immediate deficit reduction and short-term macroeconomic
stability, Congress chose the latter, effectively pushing most difficult deficit-reduction choices to
another time.
ATRA avoided steep increases in tax payments by permanently extending several
ongoing tax cuts that had been scheduled to expire, many of which had been extended annually,
sometimes retroactively.2 The alternative minimum tax patch was indexed permanently to
inflation, preventing another 30 million taxpayers from almost immediately having to pay the
tax. Income tax cuts originally enacted during the Bush administration were extended for
taxpayers with incomes below $450,000 if married and $400,000 if single. The estate tax rate
was set at 40 percent, while the per person exemption was set at $5 million and was indexed to
inflation.
Several more moderate tax cuts were extended for less than 10 years. Regular extenders,
such as the deduction for state and local sales taxes paid and the research and experimentation
1
The Congressional Budget Office score of the bill, released January 1, 2013, is available here:
http://cbo.gov/sites/default/files/cbofiles/attachments/American%20Taxpayer%20Relief%20Act.pdf.
2
A more complete description of ATRA’s provisions is available here:
http://www.taxpolicycenter.org/UploadedPDF/412730-Tax-Provisions-in-ATRA.pdf.
1
(or R&E) tax credit, were continued for 2013 only. Refundable tax credits established under
2009 stimulus legislation, such as an expansion of the Hope tax credit into the American
Opportunity tax credit, a modest expansion of the earned income tax credit, and the extension of
a child credit to lower income levels, were extended for five years.
Several tax cuts were not extended. Taxpayers above the $400,000/$450,000 threshold
will pay statutory tax rates that existed under the Clinton administration, before the 2001 and
2003 tax cuts. A 2 percentage point payroll tax cut, widely envisioned as temporary, was also
allowed to lapse.
On the spending side, ATRA did little more than suspend the scheduled sequester of
domestic discretionary and defense spending for two months by lowering the amount of
sequestered funds for fiscal year 2013 by $24 billion. (This was partially offset by later cuts in
discretionary spending and by a budget gimmick related to Roth retirement accounts that allows
retirement savers to prepay tax liability at a long-term loss to the Treasury.) ATRA also delayed
for one year large scheduled cuts in physicians payments under Medicare, a routine practice by
policymakers often referred to as the “doc fix.”
By making many tax provisions permanent, ATRA addressed several long-standing tax
policy questions, but it did little to address budget uncertainty. Seemingly overnight, the
lingering tax policy uncertainty that had plagued the policy arena since 2001, when tax cuts
enacted then were scheduled to expire, was transformed into spending uncertainty. As of January
2013, Congress is staring down numerous debt ceiling extensions, the scheduled implementation
of the first stage of a sequester, and the expiration of the continuing resolution—the legislation
authorizing funds for the federal government to continue its operations. In addition, the “doc fix”
is scheduled to expire at the end of the year.
Deficit reduction relative to past policies was primarily achieved through higher taxes on
households above the $450,000/$400,000 threshold. These households will see their income
taxes rise to Clinton administration levels and their tax rates on capital gains and dividends will
rise to 20 percent (in addition to the scheduled surtax enacted through the Affordable Care Act).
Deficit Reduction under ATRA
A congressional failure to pass legislation bypassing the fiscal cliff would have put the United
States on a path to a sudden, very large deficit reduction that would have almost certainly
ensured the onset of a moderate to severe recession. Deficit reduction and the government
component of economic growth are unavoidably opposite sides of the same coin.
Without action and before taking account of the impact on the economy, the deficit as a
percentage of the economy would have plummeted from 7.0 percent in 2012 to 4.0 percent in
2013 and 0.4 percent in 2018, before inching upward for the remainder of the budget window.
2
Steep and severe cuts in government spending combined with rapid increases in tax revenues,
however, would have made near-term economic growth nearly impossible, leading again to very
large deficits. Since 1970, the largest single-year reduction in the deficit as a share of GDP was
1.8 percent, and the most rapid five-year reduction was 3.8 percent (which coincided with swift
economic expansion at the end of the 1990s). The levels under previous law would have
exceeded both. The limited deficit reduction under ATRA (never more than 1 percentage point
of GDP in any year after the economy is assumed to recover) in the short term, therefore, allows
the tepid recovery to continue and hopefully expand toward stronger economic growth.
On the flip side, the law in place post ATRA, now the new “current law,” represents toolittle deficit reduction given long-term budget pressures. According to our analysis, current-law
deficits will drop to 6.1 percent of GDP in 2013 and 2.6 percent of GDP in 2018, before rising
steadily through 2022. Such a deficit-reduction path would represent meaningful progress, but
the fairly large and growing deficits toward the end of the 10-year budget window demonstrate
that even this path leaves quite inadequate adjustments for the growing demographic and health
care cost pressures that continue to accelerate.
8
Federal Deficits under Three Budget Assumptions
(percentage of GDP)
6
Post-ATRA current policy
ATRA
4
2
Previous law
0
2012
2013
2014
2015
2016
2017
Source: Authors' calculations from CBO data.
2018
2019
2020
2021
2022
Unfortunately, as before ATRA was enacted, a “current law” deficit reduction path is not
meaningful because it does not reflect past policymaking behaviors that lawmakers are likely to
repeat. Congress failed to address several ongoing polices that will likely require attention in
2013. Among the principal items that current law requires, but that no one fully expects to
happen, are a fairly severe cut in defense and domestic discretionary spending under
sequestration, the expiration of the “doc fix” in 2013, and the expiration of some refundable
credits benefiting lower-income taxpayers in 2017. Removing these and other related sources of
deficit reduction leads to a more realistic assessment of a “plausible current policy scenario”
3
(table 1).3 Deficits fall from 6.4 percent of GDP, or $1.015 trillion in 2013, to 3.4 percent of
GDP in 2017, then start on another upward path throughout the remainder of the projection
period. Such a deficit path maintains many of the economic pitfalls associated with high budget
deficits and public debt, as well as a weakened ability to respond to any new recession, foreign
crisis, or other emergency.
Current Policy under ATRA Subject to Floors in Discretionary Spending (percentage of GDP)
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Defense discretionary
4.3
4.1
3.8
3.5
3.3
3.1
3.0
3.0
3.0
3.0
3.0
Domestic discretionary
4.0
3.8
3.9
3.7
3.5
3.3
3.2
3.2
3.2
3.2
3.2
Mandatory
13.2 13.6 13.5 13.4 13.6 13.4 13.4 13.6 13.9 14.1 14.5
Net interest
1.4
1.4
1.5
1.5
1.8
2.2
2.7
3.0
3.3
3.5
3.7
22.9 22.9 22.7 22.1 22.2 22.1 22.2 22.8 23.3 23.8 24.4
Total outlays
15.7 16.3 17.8 18.4 18.6 18.8 18.7 18.7 18.8 18.9 19.0
Revenue
-7.3 -6.5 -4.9 -3.7 -3.5 -3.4 -3.5 -4.1 -4.5 -4.9 -5.4
Deficit (-)
Source: Authors’ calculations.
Preparing for the Future
The budget outlook remains treacherous. Three notable “cliffs” or obstacles require resolution in
the near future and potentially many times thereafter: the continuing points of exhaustion of
borrowing authority by Treasury associated with running into debt ceilings; the effective
implementation of sequesters, the first occurring in spring 2013; and the expiration of various
continuing resolutions.
While these events all constrain government spending in some fashion, they do so in very
different ways and with dramatically different consequences. If Congress does not increase the
Treasury’s authority to borrow, the government could lose the ability to pay its bills, including
Social Security payments, interest payments on Treasury bonds, and government worker salaries.
The financial system would be in chaos, and interest rates would likely spike to an
unprecedented level. Economic growth would plummet.
3
Many of the differences between current law and current policy here are similar to those of CBO in its alternative
fiscal scenario and the Committee for a Responsible Federal Budget (CRFB). We especially thank the latter for
allowing us to review and use several of their calculations in the period before CBO’s February 2013 update. CFRB
analysis of the fiscal cliff can be found here: http://crfb.org/blogs/good-bad-and-ugly-fiscal-cliff-package. Our
primary difference with CBO (under an estimated update) and CRFB is that we assume that domestic discretionary
and defense discretionary will not continue falling below their multidecade lows of 3.0 percent of GDP and 3.2
percent of GDP, respectively. We have also included in current policy the so-called extenders (excluding bonus
depreciation) that are routinely adopted year after year, as does CBO but not always CFRB. Like CRFB, we assume
a faster war drawdown.
4
The effects of the other two obstacles are more subtle. A failure to address the sequester
would result in crude cuts in defense and nondefense discretionary spending, in addition to some
mandatory programs like Medicare. Some federal employees would be furloughed; many
agencies would stop hiring if they have not done so already. The cuts would be arbitrarily
applied, with little or no adjustment for policy concerns. The effects of an expired continuing
resolution would be more severe. The federal government would not be able to authorize
spending for discretionary programs, and nonessential government services would shut down.
Reverberations would be felt in the wider economy but would be much less severe relative to the
exhaustion of Treasury borrowing authority.
While potential short-term crises abound because of these arbitrary cliffs, they can be
avoided somewhat easily by simply ending that type of policymaking. Unfortunately, long-run
demographic and health spending pressures still persist and threaten to cause real budget
problems in the future, regardless of any cliffs. Ten-year budgets mask the even tougher period
coming in the 2020s, at least when it comes to demographics and health care costs. The latter
will be growing off an even larger base, while baby boomers will begin to swell the number of
those reliant upon Social Security toward 30 percent of the adult population. Moreover, the baby
boomers will start moving into their mid-70s and beyond, when health, long-term care, and other
needs rise.
These longer-term concerns differ fundamentally from the short-run crisis of today; their
movements are slow, yet inexorable, and at rates faster than the economy and revenues are
growing. If current beneficiaries are protected, however, reform can only gradually slow that
growth rate. Today we have ample warning about the magnitude of these budget shortfalls:
CBO’s most recent long-run outlook shows deficits of 7.7 percent of GDP and public debt at
nearly 200 percent of GDP in 2037.
Turning back to the intermediate term, and ignoring politics, Congress can set a deficitreduction path that does not overburden the continued recovery, while also establishing a
framework for long-run deficit reduction. A minimal guiding principle for congressional
budgeting in normal times, and absent automatic growth in mandatory programs like health and
retirement, is to achieve primary account balance—that is, balancing the budget outside of
interest payments—when the economy has recovered and is at full employment.
Achieving this path for the intermediate term would be difficult but not insurmountable.
The chart below shows the gap between the current policy deficit and interest payments—the
amount needed to achieve primary balance. Congress could gradually reach this path over the
5
next several years by, for example, cutting the deficit $150 billion relative to current law for each
year between 2015 and 2018, and $300 billion in each year thereafter.4
Still, absent dealing with longer-term pressures, even that type of reform is likely
unsustainable. As long as so much spending growth is built into the budget indefinitely, the
country will simply go from fighting one deficit battle to the next. Programs for children,
investment, and other projects become further squeezed, while little or no room remains to deal
with new recessions or emergencies. The suggested intermediate-term deficit-reduction path
implies moderate spending growth, but if all that spending is determined by past laws, then there
is little or no ability to deal with any new requirement or pressure on the economy without more
deficit spending or deficit reduction.
The bottom line is, we have a long way to go.
Primary Deficit under Three Policy Scenarios
(percentage of GDP)
6
5
4
3
2
Current policy
1
Current law
Proposed reduction
0
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
-1
Source: Authors' calculations from CBO data.
Notes: Primary deficit is total deficit excluding net interest payments. "Proposed reduction" assumes $150
billion in deficit reduction relative to current policy between 2015 and 2017, and $300 billion thereafter.
4
The Center on Budget and Policy Priorities (CBPP) makes a similar argument, claiming that $1.4 trillion in deficit
reduction—$1.2 trillion in direct cuts and $200 billion in interest saving—will stabilize the debt-to-GDP ratio.
CBPP’s brief is available here: http://www.cbpp.org/cms/index.cfm?fa=view&id=3885.
6